Budgeting for Hard Choices – in 2011

Central government current receipts in February were 9.8% lower and current spending in February was 6.5% higher than in the same month last year, the IFS reported today (19 March 2009). What a surprise.

As government income drops and spending increases all eyes will be on Chancellor Alistair Darling when he announces Budget 2009 on 22nd April. But the real Budget to watch will be in Spring 2011.

Chancellor Darling has little room for manoeuvre this year – so many big spending decisions – including the awesome sums involved in the bank-bailouts – have already been taken. He can’t cut taxes or increase spending very much without increasing the already dire medium-term prospects of the public finances. The national overdraft is already set to reach nearly 60% of annual GDP – 50% higher than Gordon Brown’s famous ‘sustainable investment rule’ that it should not go above 40% of GDP.

Sure, Mr Darling will be under pressure – not least by his neighbour at No.10. Although the Conservatives has a sustained lead in the polls, the electorate is more volatile than at any time in living memory. There are signs that if the economy starts to turn around by the end of 2009 or start of 2010, some at least may come back to Labour. Whether that would be enough to save Mr Brown is another question, but it is his only hope short of a war. (Remember, Margaret Thatcher was dreadfully unpopular in 1982 when the Falklands war saved her premiership).

Three things make 2011 the Budget to watch. First, by most estimates the economy will have returned to growth by then and the ‘fiscal stimulus’ justification for higher spending and lower taxes will be gone. Second, the last possible date for a General Election is May 2010 – after the 2010 Budget. Assuming Gordon Brown takes it down to the wire, the first full Budget of the new government (Labour, Conservative or coalition) will be in March 2011. Third, and least importantly, on the current 3-year public spending cycle this would also be the start of a new 3-year cycle (assuming a new government keeps this system).

By 2011 the public finances will be in a terrible state. Total borrowing will have exceeded £1 trillion and on current estimates the IFS reckons it would take until 2030 to get back to pre-crisis levels. The structural deficit is so big that only either big tax increases or substantial real-terms cuts in public services will even start to get things under control.

My estimates are that during the 2011-12 to 2013-14 spending cycle simply to stop the increase in total public debt would require something like a 5% per year cut in real-terms public spending. This would be by 2013-14 a cut of almost 17% or £125bn in total public spending – or roughly the equivalent of abolishing the National Health Service.

The problem for the 2011 Chancellor is that we wouldn’t have until 2030 to get the public finances back on track. Assuming economic cycles revert to their more normal trend over the past 30 years, then we can expect another slow-down at least within 8-10 years after this one finishes – i.e. by about 2020. So even if the new Chancellor sets out to set things right by then he or she will still be looking at substantial tax rises and/or public spending cuts for the next spending cycle.

Of the two main parties this would probably be most difficult for the Conservatives. They have reacted to the current crisis by positioning themselves as ‘fiscal conservatives’ – balanced budgets, reducing borrowing, and cutting spending plans have already been hinted at. But if they put the entire burden on to spending cuts they would have to carve great chunks out of public services. The only alternative is also to put up taxes – which would be logical for real fiscal conservatives but politically catastrophic.

So far the Tories problem has escaped serious media scrutiny – and maybe they will escape right up to the Election given how unpopular Labour is and the bias of our main newspapers. But come Budget 2011 the buck would have to stop. Fiscal conservatism may make a good sound bite now, but it makes for some very unpalatable policy choices down the road.

If, by some miracle, it is a Labour chancellor making the decisions for Budget 2011 the prospect is slightly – but only slightly – better. The key would be ‘fairness’ – an idea Labour has already latched on to but put little flesh on. After the visceral anger at the palpable unfairness of bankers walking away with huge personal gains even as they wrecked the banks and the economy, the way is more open for putting higher taxes – especially for the better off – back on the political agenda.

PS [20 Mar] – Labour seems to have already won one the first round in this battle – having already pledged to raise the top rate of tax from 40% to 45% for those earning above £150,000 the Tories have announced today (20th March) they would not reverse this change –Daily Telegraph. Although this is expected to raise £2bn, there is clearly still a lot more Labour could do about the highly unpopular ‘bonus culture’ at the top of British business and the huge and growing inequality gap.

If Labour could also visibly reorder spending priorities aimed at greater fairness, even whilst reigning back spending, the results could be more palatable to the majority of the electorate.

But whoever is Chancellor in 2011 they have some very, very, hard choices to face.